GHG regulation - a multi-layered approach

A key question for the Kyoto2 system for regulating greenhouse gases is how it would relate to other systems, such as the Kyoto Protocol's country-based system (Kyoto1), the EU's Emissions Trading System (EU-ETS), and the various flavours of Individual Carbon Trading (Domestic Tradable Quotas or DTQs; Tradable Energy Quotas or TEQs; and Personal Carbon Allowances or PCAs). This short paper suggests that these different approaches can co-exist and co-operatively contribute to the greater goals of reducing greenhouse gas (GHG) emissions while also contributing to social and economic progress.

As originally conceived, the Kyoto2 system was a replacement for the existing Kyoto1 approach based on country allocations of GHG emissions rights. It was also thought that it would render personal carbon quota systems (DTQs / TEQs) unnecessary. However it is now apparent that there is space for different regulatory systems for GHGs to operate simultaneously, each serving a separate but related function.

Kyoto1

As a means of reducing GHG emissions Kyoto1 is clearly inadequate:

it places no obligations on the rapidly industrialising countries where GHG emissions are rising fastest
the fastest growing sector for GHG emissions, aviation, is excluded
an entire family of powerful greenhouse gases, the CFCs and HCFCs used in refrigeration and air conditioning, are not listed in its Annex A and are thus unregulated from a climate perspective (although they are subject to separate regulation under the Montreal Protocol)
the choice to regulate greenhouse gases according to their country of emission, rather than their country of production or the country in which the the end products of manufacture are consumed, is arbitrary, lacks rigour and creates inconsistencies
there has been no observable decrease in the rate of increase of GHGs in the atmosphere since Kyoto1 was signed and came into force, indeed the reverse has taken place.

As such Kyoto1 is inadequate to the task in hand. However it also has some positive attributes that it would be unwise to discard:

it engages national governments (of Annex 1 countries) in the process of reducing GHG emissions and thuis brings an important impetus and raft of resources to efforts, including legislation (such as the UK's forthcoming Climate Act), taxation (such as the UK's Climate Change Levy and automotive fuel taxes) and expenditures.
although there is no compliance mechanism to penalise countries that fail to meet their Kyoto1 targets, national pride is a powerful motivating force, as to is the avoidance of the national shame that would follow from non-compliance.

We must also remember that the Kyoto1 system is now firmly established. The considerable commercial activity that surrounds it and its flexibility mechanisms - such as the Clean Development Mechanism (CDM), Joint Implementation (JI) and Carbon Trading - has created a powerful interest in its retention. It appears likely that whatever system replaces the Kyoto Protocol on its expiry in 2012 will resemble Kyoto1 and perpetuate its core themes.

Accordingly it is no longer proposed that Kyoto2 would need to replace Kyoto1. The two regimes could perfectly well operate alongside. In this scenario, Kyoto2 would be the dominant system in that it would create a global cap on GHG emissions and so define the overall "envelope". However the simultaneous retention of the Kyoto1 approach could positively contribute as follows:

the pressure on Annex 1 countries to reduce their national emissions would tend to reduce the cost of Kyoto2 Rights, and so reduce costs to business and to consumers; while also freeing up Rights for use in poorer (non-Annex 1) countries in accordance with development objectives.
the continued role of the Kyoto1 flexibility mechanisms would continue to raise new, additional finance for GHG emissions reductions in both non-Annex 1 countries (through the CDM) and indeed in Annex 1 countries (through JI).

Individual Carbon Trading

The idea of instituting a system of Individual Carbon Trading (ICT), based on personal allowances known variously as DTQs, TEQs and PCAs is gaining in popularity. These systems would apply within individual countries (or larger regions). Personal accounts would be debited for every energy purchase - to include automotive fuel, flights, gas and electricity. Those using more than their personal allocation would need to buy unused allowances from people who had used less than their allocation, on a secondary market.

Such systems would not be necessary under a Kyoto2 regime. However they would be entirely compatible, and contribute to the overall aim of reducing the demand to emit GHGs. The creation of an ICT system in a country would:

create economic incentives to reduce energy use and to switch to lower-carbon energy sources, so reducing national GHG emissions.
directly involve individuals and families in broader efforts to reduce climate impacts, raising awareness of the issues and a sense of personal responsibility for tacking the problems of climate change.

The EU-ETS

The EU-ETS is in many ways even more deeply flawed than the Kyoto Protocol, in that it both allocates GHG emissions reduction targets to EU member states, while at the same time allowing major industries to trade in Allowances (EUAs) thus potentially subverting those national targets. The over-allocation of EUAs in Phase 1 of the EU-ETS has led to a very low price for EUAs (falling to around €1 /tCO2e in March 2007) so allowing UK generators to switch from gas to coal generation at low cost. As a result the UK, while still within its target, has seen substantial increases in GHG emissions in 2006 / 2007 which the Government has no obvious "policy handle" to bring back down.

In addition the "grandfathering" of EUAs (their allocation at no cost to polluters based on past emissions) has given € billions of surplus profits to the recipient power companies and other major energy users.

However the situation is expected to improve in Phase 2, with tighter allocations of EUAs, while the system will expand to cover a greater proportion of the EU's emissions, encompassing the medium-size business sector. In addition emissions from aviation are to be brought into the EU-ETS. A proportion of EUAs will also be auctioned rather than allocated.

As with Kyoto1, the EU-ETS is a fact of life, indeed the market in EUAs is by far the biggest sector of carbon trading, turning over some $19 billion in 2006, compared to about $3 billion under the Kyoto1 flexibility mechanisms.

As with Kyoto1, the EU-ETS (suitably reformed) could carry on in parallel with a Kyoto2 system and contribute to its objectives.

The interesting suggestion has also been made that the Kyoto2 system might initially be applied within the EU alone. If this were to take place it almost certainly would eventually come to replace the EU-ETS.

Inter-relationships

In one view, the different approaches to GHG regulation could simply carry on independently. Thus, for example, the UK might simultaneously be subject to Kyoto2, Kyoto1, the EU-ETS and an Individual Carbon Trading scheme, each operating within their own sphere. However there is also the possibility of cross-linkages between the different schemes, for example:

The EU-ETS is already related to Kyoto1, which it partially interprets in the EU context.
Kyoto2 funds could be used to purchase carbon instruments (CERs or ERUs) created by Kyoto1 flexibility mechanisms. These purchases could be targetted at sectors and countries that have largely been bypassed by the commercial sector to date, which has concentrated heavily on industrial GHG emissions from rapidly industrialising countries.

Conclusion

Diverse approaches to the regulation of GHGs are generally compatible and often mutually supportive. The operation of the Kyoto2 system would not require the termination of other systems in force or proposed, and could operate in parallel with, for example, Kyoto1 and Individual Carbon Trading.

Oliver Tickell, 4 April 2007.